ISDA: Markets Likely to Avoid Disruption from VM Rules

The derivatives industry can breathe a sigh of relief regarding new variation margin (VM) requirements, as it now looks like majority of market participants will be ready for them, according to the International Swaps and Derivatives Association (ISDA).

In a posting on the ISDA website, the association’s CEO, Scott O’Malia, notes that as recently as six months ago “the industry was facing the possibility of real disruption”.

“With the variation margin ‘big bang’ set for implementation on March 1, but with only a fraction of the necessary changes to documentation completed, there was a very material risk that a large part of the market wouldn’t be able to trade,” he comments.

O’Malia highlights the decision taken by regulators across the globe, including the Commodity Futures Trading Commission (CFTC) in the US, to not enforce the VM requirements that were due to come into effect for swap dealers (SD) on March 1 for an additional six months, as a key factor in this turnaround.

This delay enabled market participants to continue trading under their existing documentation and provided extra time for firms to continue the lengthy and complex process of amending or creating credit support annexes (CSAs) with in-scope counterparties, according to O’Malia.

He adds: “That extra time was critical, as final national rules had only been published just months earlier in some cases, leaving a very small window for firms to complete what was essentially a colossal repapering exercise.”

At the end of February, ISDA estimated that the proportion of required CSA amendments that had been completed by market participants stood at one third. By contrast, the association reckons that 90% had been amended by the week ending August 11.

Although this 60-odd percentage-point increase means that many derivatives market participants can breathe a sigh of relieve, O’Malia warns that the industry should not get complacent, pointing out that there is still a tail of mostly smaller firms that needs to be worked through in the coming weeks and months.

“The question is what happens to those trades executed after March 1, in line with the regulatory forbearance, but where CSAs have not yet been amended?” questions O’Malia.

He continues: “The industry is working on the basis that those trades will need to be unwound if they are not subject to regulatory compliant variation margin CSAs by September 1. Given firms lack a contractual mechanism to unilaterally force their counterparties to unwind, it will take time to negotiate the terminations – but firms want to be able to demonstrate they’ve been working to tackle the issue in advance.”

The rollout of the variation margin requirements doesn’t mark the end of the non-cleared margin implementation effort, however. The European Union (EU) will bring physically settled FX forwards into scope of the non-cleared margin rules from January 3 – the only jurisdiction to do so – which will result in another wave of CSA negotiations.

While a small number of so-called phase-two firms will post regulatory initial margin from September 1, a larger number of counterparties are set to follow suit in September 2018, 2019 and 2020.

ISDA’s work will persist as the rules continue to evolve. That includes the monitoring of preparations for the EU FX and phase-three initial margin implementation deadlines, the development of any necessary documentation solutions, and ongoing updates to the ISDA SIMM. ISDA is committed to working with the industry to develop solutions to help firms with their compliance efforts,” comments O’Malia.